First Merchants Corp (NASDAQ:FRME)

Deteriorating Professional Opinion

My record on small banks is rather dismal thus far. I've had some big successes on the large cap banks (such as BAC, BBT, and STI), but all my small-cap bank selections have been absolutely destroyed or, in best-case scenarios, traded sideways. Yet, I persist in picking these things for some idiotic reason. Maybe I'm convinced that I can eventually learn this sector or maybe I'm still attracted to the unbelievable amount of bearishness in the sector.

FRME is trading at a 52-week low, but I can see no reason as to why except that the market is terrified that any and every small cap bank is going to get shut down by the FDIC. There's also the fact that FRME's most recent earnings look kind of ugly, but after looking at their historical performance, I'm left to wonder whether their auditors are requiring them to be overly conservative in their allowance for loan losses, which is almost 7X the amount it was over the equivalent period last year.

FRME recently acquired Lincoln Bank Corp, which also accounts for some of the pessimism in their financial statements. While I might be foolish to see their acquisition as a sign that they are, in fact, still in good shape --- I'm tempted to reach that conclusion. It actually allowed them to grow significantly at a very cheap price. In fact, their revenues are higher this year than they were last year, which is rarer than rare in the banking industry. As I said, the only thing that suppresses their earnings is the extremely high allowance for loan losses.

There has been a large number of inside buys over the past nine months, as well. This might not mean much of anything, if my research on commercial banks says anything about it (http://seekingalpha.com/article/118150-insider-transactions-at-commercial-banks), but it's not a bad sign either.

FRME's balance sheet looks to be in reasonable shape to me. Liquid assets comprise roughly 16% of total assets, which is significantly higher than most banks I've encountered. Tangible common equity is worth about $14.10 per share. Even if I increase their allowance for loan losses to 5% of the total value of their loan portfolio, I still come up with adjusted common equity of about $9.50 per share.

Historically, earnings for FRME have been upwards of $1 per share. It's difficult to say what the "new normal" will be for this bank, but given the acquisition of Lincoln, it is possible that they will earn this much again at some point. At the current price, even if they only earned 50 - 75 cents per share on a yearly basis in the future, this still might not be that bad of a deal.

FRME is trading at a 52-week low and the current dividend yield is about 4.9%. Who knows whether that will hold up or not, but I think this bank will survive from my scanty research. I see no real evidence that it's on the brink of collapse or anything, even if the market believes that to be the case. Then again, I see no real evidence that I know anything about successfully investing in small-cap banks, so that's food for thought.